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Sunday, May 10, 2009

Need better information for minority shareholders

by Ravi Purohit.

Some examples

Siemens Ltd. (14 Jan 2009) sold its IT division to its parent co. and came out with a matter of fact press release to the shareholders and the rest of the world saying it's divesting a low-margin business. The consideration: Rs.449 crore, for a business that earned Rs.994 crore in revenues and Rs.73 crore in net profit, in effect valuing it at a modest P/E of 6 times. The very same business in 2007 had earned a net profit of Rs.160 crore. Why should Siemens sell this company for such a low consideration? Shouldn't they be sharing the valuation report submitted by Grant Thorton with shareholders (so that everyone knows the basis for such a low valuation), just like they send their Annual Report? [link]

Lok Housing & Constructions Ltd. (30 Jan 2009) made an announcement saying all the profits it earned in the last three years will have to be written back. Reason: Customers cancelled contracts. Action taken by the Company: It mutually agrees to let legally-bound customers cancel all the contracts, thereby saying that all the profits it reported in the last three years were non-existent! [link]

Sterlite Industries (India) Ltd. (9 Sep 2008) Board cleared a proposal to restructure its business by transferring the Aluminum business (including stakes in BALCO & Vedanta Aluminum) and the power business (i.e. 100% stake in Sterlite Energy) to Madras Aluminum (a much smaller company with a mcap of less than 1/15th of Sterlite's). Further, the proposal also included a tranfer of Vedanta's (Sterlite promoters) 79.4% stake in Konkola Copper Mines in favour of Sterlite Industries for a 1:1 ratio. The transfer of this business would have resulted in a significant jump in Promoter's holding in Sterlite Industries. Reasons for this restructuring as given by the Management: Increase in efficiency, simplification of corporate structure, and elimination of conflict of interest [link]. The point is not whether the such proposals are fair, but whether companies share sufficient information with shareholders so that they could make an informed decision on their investments. In the case of Sterlite Industries, given the scale of restructuring it was only fair on the part of the Company to disclose basic details like impact on the Profit & Loss Account, the Balance Sheet of each of the three companies, impact of increase in efficiency on profits and profitability, basis for valuing Konkola Copper Mines (one share of which was valued on par with one share of Sterlite Industries), etc. Media reports suggest that protests from certain large foreign funds and a big thumbs down to the share price pushed the management to cancel the restructuring proposal for the time being. [link]

S R F Ltd. (16 Dec 2008) announced its decision to purchase two businesses of SRF Polymers (the main promoter company for SRF) for a consideration of Rs.151.8 crore [link]. Consider this: when the announcement was made, SRF Polymers had a market cap of Rs.64 crore. Further, SRF Polymers on a cumulative basis has not made any net profit in the last five years. So why should SRF pay Rs.152 crore for a company that is a). loss making, b). has a debt of Rs.130 crore (as of FY08) and is trading at less than half that value on the bourses any which ways? Important data point: SRF's promoter SRF Polymer and SRF Polymer Investments own 45% in SRF), whereas the group's real promoters (Mr. Bharat Ram and group) own 74% in SRF Polymers.

Satyam Computer Services Ltd. (16 Dec 2008) tried acquiring two of its sister concerns Matyas Infra and Maytas Properties, offering handsome valuations for both companies with `un-related' businesses, but with high promoters (read: the Raju family's) holding [link, link]. The rest is history, but it was yet another attempt to short-circuit minority shareholders.

D L F Ltd. (23 Mar 2009) may try to do something like SRF, according to the pink papers, which suggest that the Company is planning to take a controlling stake in DLF Assets, a company owned by DLF Promoters (the KP Singh family). However, there is no official announcement or proposal that the DLF Board had cleared to this effect. But, neither have they denied the news. In a response to a related article carried in the Business Standard [link], DLF said "The Company has been looking at various options from time to time; however, no definite option has been presented to the Board so far for its Consideration". [link]. In another article dated 1 May 2009, it was reported that DLF has formed a committee of Independent Directors to look at options for DLF with regard to its relationship with DLF Assets Ltd. The Committee will look at various options, which includes a possible acquisition of stake by DLF. [link]

The big question is: Why should DLF buy a company for Rs.6-7,000 crore (as mentioned in the Business Standard report) that owes it more than Rs.5000 crore in dues? The same Business Standard report also makes a mention that the merger of DLF Assets is primarily being done to provide an exit to some of the funds who are invested in DLF Assets. Rumour or reality, we do not know. What we do know is that DLF is under significant financial stress right now. Consider this: For the quarter ended 31 Mar 2009, DLF reported a 74 per cent drop in revenues and a net loss (after adjusting for other income) of Rs.70 crore as compared to an adjusted net profit of Rs.2,141 crore in the year ago quarter.

Ray Ban Sun Optics India Ltd. (30 Apr 2008) transferred its business of distribution and sale of various luxury frames and sunglasses (that includes Dolce & Gabbana, DKNY, Ralph Lauren, Oakley, etc.), other than RayBan to Luxottica India Eyewear Pvt. Ltd. (a wholly owned subsidiary of the Luxottica group, also the promoters of RayBan Sunoptics, upon the former's instructions). Effect: Around 40% of Rayban Sunoptics' revenues came from the distribution business. And even though it was low-margin affair, it did not require any capex from Rayban Sunoptics' end, so in effect it had a fairly decent ROCE. But, yet it was transferred. After a couple of months, Luxottica de-listed Rayban by making a public offer at Rs.140 per share. Had this business included the trading business, would the minority shareholders not have received more consideration? [link, link]

Zee Entertainment Enterprises Ltd. (22 April 2009), in its quarterly results press release, announced that it has increased its holding in one of its subsidiaries, Asia Business Broadcasting (Mauritius) Limited, from 60 per cent to 100 per cent. The deal involved a cash payment of USD 56 million (approx - Rs.280 crore) to some Resource Software Ltd., valuing the overall company at USD 140 million (10 times FY09 sales and 20 times FY09 net profit). What made Zee take this step when it any which ways controlled the Company given its 60 per cent holding? Why did it not choose to repay some of its debt on which it paid an interest of over Rs.130 crore in FY09? How justified is it to pay 10 times sales or 20 times profit, given the kind of turmoil we've seen on stock markets in the last one year? What does this company called Resource Software Ltd do, who owns it, and where is it located?

Last but not the least, the mysterious case of Orissa Sponge Iron:

Here's a Company that is currently in the midst of a three-way takeover bid (bid details 1, 2 & 3), with each of the bidding companies willing to value the Company in the north of Rs.600 crore. That for a Company which in the last five years made a cumulative loss of Rs.5 crore. What's more as of 31st March 2008, it had a debt of Rs.229 crore (which I think has now increased to close to Rs.300 crore, but that's just a rough estimate based on the interest payments made by the Company in recent quarters).

So where is the profit potential? What are these companies paying for here?

Orissa Sponge has applied for iron ore mines and coal mines in Orissa and is awaiting some final leg clearances from the State Government. But, in the Annual Report for FY2008, the Company makes no mention about the size or the quality of ore in the mines (in a way that would help shareholders appraise the Company's value and compare the same with its market capitalization). There are news/brokerage reports that suggest that the DCF value of these mines could be in the range of Rs.2000-4000 crore. But, they are all based on unconfirmed reports & estimates. But, if that is indeed the case, shouldn't the Company be sharing information with minority shareholders to enable them to appraise whether to tender their shares in the ongoing bidding war for control?

Well, it seems that the takeover bid is not the only war the Company is involved in. There have been scores of reports in the media (link1, link2) about the promoters of Orissa Sponge Iron allegedly flouting SEBI's takeover code and increasing their stake in the Company at various instances in the past. Let me try to simplify things here:

Orissa Sponge Iron's total promoter holding in June 2005 was 62.7%.

This was increased to 69.3% by December 2006 (by way of conversion of warrants).

The SEBI takeover code (that was prevalent before the changes made in 2008) mentioned the following about trigger points for making an open offer:

Regulation 11(1): Between 15% to 55%, an acquirer may consolidate to the extent of 5% in any financial year without an open offer. Any acquisition beyond 5% in a financial year would entail an open offer of 20%.

Regulation 11(2): Any acquirer who is at or above 55% but below 75% cannot purchase any additional share or voting right without making a public offer for 20%.

Regulation 11(2A): Any acquirer holding above 55% but below 75% who desires to consolidate his holding may do so by means of an open offer to the extent of the applicable limit for continuous listing.

From the above it is quite clear that the Takeover code requires an open offer to be made in case there is an increase (even if by a single share) in the share holding of an acquirer who is at or above 55% but below 75%. While calculating shareholding, the rule allows the shareholding of persons acting in concert to be added up. In Orissa Sponge's case, the matter is still open for debate, but there is a possibility that the acquisition violates the Takeover Code assuming that it is proved that all the various entities which were classified as promoters were acting in concert. Further, Orissa Sponge Iron included Unitech Holdings (that held around 7-8% stake in Orissa Sponge during the aforesaid period) as a part of Promoters & Persons Acting in Concert group, despite Unitech group's claim (as stated in a clarification provided by Mr. Sanjay Chandra to DNA) that it was merely an investment in their personal capacity and that they were never involved in the management of the Company [link]. Funny, Orissa Sponge Iron includes an investor as a promoter, wonder why?

The table below indicates changes in the holding pattern for Orissa Sponge Iron and it makes for quite an interesting read.

Promoters Hldg as reported

Promoter's holdings

Addnl share /

Avg price

(%)

(shares)

(net of Unitech investment)

sale of shares (-)

(of H, L & Cl.)

Jun'05

62.70

7452849

6529949

59

Sep'05

62.70

7452849

6529949

0

53

Dec'05

62.75

7467949

6545049

15100

42

Mar'06

59.10

7736465

6813565

268516

28

Jun'06

-NA-

-NA-

Sep'06

66.00

8639485

7716585

903020

24

Dec'06

69.31

10049485

9126585

1410000

28

Mar'07

-NA-

-NA-

Jun'07

62.81

9106865

9106865

-19720

34

Sep'07

62.71

9093385

9093385

-13480

72

Dec'07

45.07

9013628

9013628

-79757

500

Mar'08

43.80

8759459

8759459

-254169

444

Jun'08

43.80

8759459

8759459

0

239

Sep'08

43.80

8759459

8759459

0

229

Dec'08

41.51

8301249

8301249

-458210

105

Mar'09

48.98

15301249

15301249

7000000

143

So where do all the aforesaid instances leave the minority shareholders?

Quite predictably, they remain at a serious disadvantage vis-a-vis the promoters. Promoters may claim that since they own a majority stake in the Company their interest is equally (or more) affected than those of the minority shareholders. Maybe, the argument has some merit. But, are the minority shareholders so unimportant that Company's do not even share details & justifications for large and important transactions like hiving-off of business units (as was in the case of Siemens, Rayban, et al) or restructuring of businesses (Sterlite) or ownership of strategic assets whose value is significantly greater than what reflects on the Company's books (Orissa Sponge Iron's mines)?

What can we do?

What the regulators need to do is make it mandatory for listed companies to share key material information that relates to important transactions like Business/Capital Restructuring, Scheme of Amalgamations, Purchase/Sale of Assets/Investments to related companies, etc. Usually, in such cases various reports are prepared, viz. a detailed Scheme of Arrangement/Amalgamation (to be submitted to the High Court) or detailed valuation reports (prepared at the behest of the Company by external agencies). Companies should be required to share these with their shareholders just like it is mandatory to send Annual Reports.

Make the transaction a transparent one, based on which a shareholder can appraise his/her investment. The way to do this was shown to us by Tata Motors, where most of the details of its takeover of JLR were made available to shareholders [link]. We may agree or disagree with Tata Motors on the merits of the acquisition or the price paid for it, but at the end of the day the investor had the option to appraise his or her investment and decide whether to stay with them or walk away.

Detailed background information of all those involved in a purchase/sale transaction should be provided. For e.g. in case of Zee Entertainment, the Company paid about Rs.280 crore to a company called Resource Software for a 40% stake in Asia Business Broadcasting (in which it already had a 60% stake). Now, what is this Company? What does it do? Where is it located? and who are its promoters? These questions are not to doubt Zee's intentions, but its a question of being transparent with your shareholders.

Companies that hold Analyst Meets (one to one or in the form of a gathering) or conference calls usually share a lot more information than that available in the Annual Report or on the Company's website. And, in most cases this information is not available to minority shareholders and is neither available in public domain. Regulators must make it mandatory for listed Companies to share the transcripts of such analyst meets and concalls in public domain and that too within a stipulated time frame. Again, just the way companies like Tata Motors do it [link].

Dear Ajay,Thanks for the brilliant post. Minority shareholders rights gain an important place even in the context of corporate governance.

While most people quite agree with the view that the rights of these shareholders indeed need to be protected, the Bombay high court recently passed a ruling which says that majority shareholders can now throw out minority shareholders by effect a reduction of the capital held by minority shareholders alone.

Thanks Ajay.Minority shareholders are much more powerful in developed capital markets which results in lower risk premium and higher valuations for the shareholders. The availability of call transcript is something that can be enforced right away. But far more glaring deficiency is that many companies do not provide electronic copies of their Annual Report on SEBIEdifar on time. Even though TATAs are known for their corporate governance none of TATA Investment corporation's Annual Reports are available online. Enforcing of the existing regulations is the minimum one would expect from SEBI. Despite these glaring irregularities, why does not SEBI does impose any penalty on erring actors? Would Mr Kotecha be a free man today if he were in a developed country?Why not any disgorgement from him?

PS:Deleted earlier comment to insert the missing name of TATA group company

Concall transcripts, annual reports, valuation reports, detailed explanations for major corporate actions, analyst meet presentations/transcripts...all of these are missing for most of the companies, barring a few.

And really, these are not difficult to implement as mentioned by many others here.

Listed companies have to file their quarterly numbers within a month of the quarter ending, I think a similar mandatory requirement can be enforced upon them to share the said information in a timely manner.

There are companies who follow such practices quite diligently, eg. Lakshmi Machine Works, Tata Motors, etc. so it's definitely not cumbersome or a painfully expensive proposition.

You cannot help rumours...no well known company/celebrity/politician can!

If companies provide sufficient information & explanations in Annual Reports and quarterly results, we won't be left with too many questions to ask. At the end of the day, analyzing companies is no rocket science and it's fairly simple as explained by Ben Graham in 1930's in Security Analysis. The trouble is with the reliability or in many cases the lack of information which leads to all kinds of rumours and incessant questions.

How much information can you give in Quarterly reports? Even if provided, there is a 90 day gap which is long enough to spread rumours. Will the CEO sit and answer analyst questions or work for business growth?.

"At the end of the day, analyzing companies is no rocket science" -- I don't agree with this. Theoritically its simple if u read Ben Graham. Even if we have all information needed, there will be divergent views which makes analyzing and implementation difficult.

You can give plenty of useful information in the quarterly and annual reports (read reports by companies like LMW, Nestle India, Infosys, Wipro, all the major Aditya Birla group companies, GSK Consumer, GE Shipping, et al).

So long as it is reliable, it will suffice most of the analyst requirements, unless the analyst/fund manager is looking for the 'inside edge'.

A company's historical performance speaks a lot about what it can and has done in the past.

Today, you & I won't argue on the quality of businesses of Nestle, GSK Consumer, LMW, Titan or many such companies. Because, both of us would have sufficient information on these companies despite the fact that they don't meet analysts through the year (the only point of contact for Nestle is the one solitary analyst meet they conduct every year, same is true for LMW and GSK Consumer does not hold analyst meets although it does have concalls).

The area where both of us may have divergent views is the price we pay for our investments and that's what makes this a beautiful game. Nestle is a buy in pretty much everyone's books, but at twenty different price points.

I agree with you, company Managements should focus on running their businesses rather than answering analyst questions. The solution to that lies in reliable & timely information dissemination. How many of us today want to meet Infosys or Wipro management (unless one is a fan of Mr. Murthy or Mr. Premji)?

I've been to LMW's analyst meet not as an analyst but as a potential individual investor.

Further, last year they had put up the analyst meet presentation on their website a day prior to the analyst meet so that all investors (including non-shareholders) are on a level-footing.

The three annual reports that I've read of them had all the useful information required for me to analyze the company.

About a year back when it was trading at around Rs.1800-2000, the only call I had to take was whether the order book that they have in-hand (which was huge back then) would be converted into sales or would they face cancellations and postponements. And, it wasn't too difficult to take that call.

Even if they had put up the analyst meet presentation last yr, Is it not good coporate governance to maintain an Archive?

Btw, LMW CMD's Annual Salary is equal to L&T chief's salary!. (As per info available in public records). Is this because of promoter being CMD and largest shareholder or because of higher talent and vision?

You are right. They should maintain an archive of reports and presentations. I haven't looked at their site since last year when I had to make that investment call. Till then my experience with them as a Company was nice. I had downloaded all the stuff (ppt & ar) from their website itself. But, if it's not there now it does reflect poorly on their part for sure.

Anywys, the point is not about just LMW, it is the overall information dissemination scenario that we are talking about, right?

My point is simple, information dissemination from listed companies needs to improve, and with that I rest my case, fellow anonymous commentator! :-)

I agree that information dissemination from listed companies needs to improve.

As in LMW's case, there is enough disclosure when things are going good. But now, when they are facing degrowth the reports disappear. Same is the case with many other companies.

My question here is, during such times should we trouble the mgmt for more information or should we understand their situation and not ask for more. This should help them concentrate on long term growth. There is always a trade off here !

Ajay, what can the minority shareholder do if the regulator and/or company management does not take care of minority shareholder interest? There is no empowerment and there isn't sufficient representation of independent directors trusted by minority shareholders.

I am thinking of initiating a web based corp governance tool, though not sure if it will have business model to succeed on its own.

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